The Case for an Institutional Approach to DC Plan Investments. Is the institutional approach of investment management the “right” one at this time to help boost participants’ overall retirement readiness? According to a new white paper from PGIM, the Investment Management Business of Prudential Financial, the answer is yes.
In a paper titled “Defined Contribution Investments on Trial: In Defense of an Institutional Approach,” co-authored by PGIM Managing Director and Head of Institutional Defined Contribution Josh Cohen, CFA, and Institutional DC Analyst Matthew Perna, CFA, spell out the five characteristics of an institutional investment approach as being: outcome-oriented investments, broad asset class diversification, best-of-breed investment management, a thoughtful mix of active and passive options, and vehicle agnostic. Cohen and Perna make the “case” for an institutional approach from four perspectives: investment, fiduciary, wellness, and fairness:
- The Investment Case: Enhancing risk-adjusted performance — Most institutional portfolios include exposure to both active and passive management. In addition, active management comes at a higher cost, but the benefits of alpha over long horizons can be significant. Active managers have historically outperformed in down, volatile markets, which is a potential benefit to participants who are susceptible to stress, or sequence of return risk close to retirement age.
- The Fiduciary Case: Putting the interests of participants first — This section highlights the trend of plan sponsors moving toward a simpler investment approach and points out how this actually creates more legal risk because it has put sponsors’ interests ahead of participants’ and jeopardized retirement outcomes.
- The Wellness Case: Improving retirement readiness — Cohen and Perna aptly observe that employees are stressed about being financially prepared for retirement and that 401(k) savings rates are lower than they should be. As such, the number of employees delaying retirement is on the rise, resulting in higher costs for employers. One way to improve retirement readiness is for sponsors to take a vehicle agnostic to investment menu design, according to the authors.
- The Fairness Case: Bringing institutional solutions to individual participants — Cohen and Perna suggest that plan sponsors consider their peers’ portfolios when designing investment options, particularly with regard to extended credit sectors, alternatives, and private assets. They give the example of private real estate, which has historically been a strategic allocation in institutional portfolios and also commonly used by individuals to build wealth.
Plan sponsors who want to learn more about the institutional approach to DC plan investments can download the full version of the white paper here. As the authors state in the paper’s introduction: “… we make a case for why adopting an institutional approach in investment design, relative to a simple approach, is crucial for improving retirement outcomes for participants. By making this shift, plan sponsors will be more equipped to meet fiduciary responsibilities, encourage a mindset towards financial wellness, and practice fairness. More importantly, plan sponsors should adopt the approach used by their institutional peers in building investment solutions if they want to be successful at helping participants meet their retirement liabilities and manage key risks.”